The Center-State finances is a confusing topic. Most of the states depend on the center for the large chunk of their revenue. There are different channels through which the center transfer funds to states. With many organizations like Finance Commission(FC), else while Planning Commission(PC) and the present NITI Aayog involved, people are only confused. Besides there are many formulae like the Gadgil-Mukherjee formula and Finance Commission formula. No, not over; we should also know about Special Category States!

Thanks to the recent efforts for greater flexibility for states, the center-state financial relations are not as complex as it was before. Things have changed from the days of Planning Commission. Many of the Central Assistance Plans have stopped or got subsumed into other awards.

Investments made from National Small Savings Fund in Special State Government Securities

(1) States’ share of taxes and Duties

42% of the total share of tax of Union will go to states. This is as per the recommendations of the 14th Finance Commission.

Note: The Finance Commission is required to recommend the distribution of the net proceeds of taxes of the Union between the Union and the States (commonly referred to as vertical devolution); and the allocation between the States of the respective shares of such proceeds (commonly known as horizontal devolution).

Note: Among states, the horizontal distribution of tax revenue is determined by the 14th FC through a formula. The finance commission formula for horizontal devolution is as below:

Fiscal capacity or Income Distance (47.5% now 50%)

Population 1971(25% now 17.5%)

Population 2011 (newly introduced by FFC – 10%)

Area (10% now 15%)

Fiscal discipline (17.5%)

Forest cover (newly introduced by FFC – 7.5%)

Update: 14th FC has taken out the 17.5% weightage given to fiscal discipline by 13th FC and allotted 7.5% to forests, additional 5% to area, additional 2.5% fiscal capacity and additional 2.5% to population.

(2) Non-Plan Grants & Loans – Finance Commission

FC have provided post-devolution revenue deficit grants for States where devolution alone could not cover the assessed gap.

While calculating grants to the States they “have departed significantly from previous Finance Commissions, by taking into consideration a States’ entire revenue expenditure needs without making a distinction between Plan and Non-Plan”.

Taking thus into account the expenditure requirements of the States, the tax devolution to them, and the revenue mobilization capacity of the States, the FFC have recommended “Post-Devolution Revenue Deficit Grants” of a total of Rs. 1,94,821 crores, for the five year period.

The States of Andhra Pradesh, Assam, J&K, Himachal Pradesh, Kerala, Manipur, Meghalaya, Mizoram, Nagaland, Tripura and West Bengal (a total of 11 States) have been identified for receiving these revenue deficit grants.

Among 11 revenue-deficit states, Jammu and Kashmir will get the maximum grant of about Rs 60,000 crore in five-year period ending March 2020. As per the recommendations, Himachal Pradesh will get Rs 40,625 crore while Andhra Pradesh will receive Rs 22,113 crore during the five-year period. Nagaland (Rs 18,475 crore) and West Bengal (Rs 11,760 crore) are also among top five beneficiary revenue deficit states.

(3) Central Assistance for State & UT (with Legislature) Plans

Note: As FC have provided post-devolution revenue deficit grants for States where devolution alone could not cover the assessed gap, many of the Central Assistance Plans are subsumed in the award itself. But for the purpose of learning, it would be better if aspirants can go through the below table and see what was the case before.

Assistance to the States under State Plans were released as per the Scheme of Financing approved by the else while Planning Commission. Assistance is released for each scheme in a definite pattern as shown in the following table. Terms & Conditions for transfer of Central Plan Assistance to States from Ministry of Finance:

1st installment 40% on approval of treasury computerization plan. 2nd installment 30% utilization of the amount released earlier on purchase of hardware/software, training of staff etc.3rd installment 30% on utilization of amount released earlier and state share of 25% & operationalization of all modules.

100% grant Central grant up to 90% of the project cost subject to Rs 90 lakh per district for North Eastern States and up to 75% of the project cost subject to Rs 75 lakh per district for other States.

Note: Normal Central Assistance, Special Plan Assistance, Special Central Assistance and Additional Central Assistance for other purposes are subsumed in the award of FC itself.

Read carefully to understand where exactly Gadgil-Mukherjee formula was used.

(a) Normal Central Assistance(NCA):

70 percent of NCA will go to 18 states while 30 percent will go to 11 special category states. The share of NCA is mostly as grants in case of special category states (90:10), while it being mostly loans in case of other states, ie 30:70 (grants: loans).

Special Category states – For allocation among special category states, there are no explicit criteria for distribution. Funds are allocated on the basis of the state’s plan size and previous plan expenditures.

Non-special Category States – Gadgil Mukherjee formula: Allocation between non-special category states is determined by the Gadgil Mukherjee formula.

Gadgil Mukherjee formula – Gives weight to:

Population (60%)

Per capita income (25%)

Fiscal performance (7.5%)

Special problems (7.5%).

However, as a proportion of total centre-state transfers NCA typically accounts for a relatively small portion (around 5% of total transfers).

Note: PC dealt with the horizontal distribution of finance, ie between states. PC had say in announcing discretionary grants to certain states (Eg: Special Category States).

Special Category status and center-state finances

The concept of a special category state was first introduced in 1969 when the 5th Finance Commission sought to provide certain disadvantaged states with preferential treatment in the form of central assistance and tax breaks. Though initially only three states were grouped as special category states, now there are 11 states enjoying special category status. They are:

Assam

Nagaland

Jammu & Kashmir

Arunachal Pradesh

Himachal Pradesh

Manipur

Meghalaya

Mizoram

Sikkim

Tripura

Uttarakhand

The rationale for special status is that certain states, because of inherent features, have a low resource base and cannot mobilize resources for development. Some of the features required for special status are:

(i) hilly and difficult terrain;

(ii) low population density or sizable share of the tribal population;

(iii) strategic location along borders with neighboring countries;

(iv) economic and infrastructural backwardness;

(v) non-viable nature of state finances.

Advantage of being tagged as special category:

Special category states also receive specific assistance addressing features like hill areas, tribal sub-plans, and border areas. Beyond additional plan resources, special category states can enjoy concessions in excise and customs duties, income tax rates and corporate tax rates as determined by the government.

(b) Special Central Assistance(SCA):

SCA were provided for special projects/programs e.g., Western Ghats Development Programme (WGDP), Border Areas Development Programme etc. This special plan assistance is given only to special category states to bridge the gap between their Planning needs and resources. In other words, SPAs are Additional Central Assistance (ACA) to special category States. Special Plan Assistance (SPA) is provided to the Special Category States for funding of projects identified by the States that are not covered by any Central scheme and for non-recurrent expenditure of a developmental nature, based on the recommendation of the Planning Commission. From 01.04.2015 onwards, there is no allocation under SPA and SCA (untied).

(c) Additional Central Assistance(ACA):

This is provided for implementation of externally aided projects (EAPs), and for which presently there is no ceiling. There can be one time ACA and advance ACA. Just like Centrally Sponsored Schemes, Center give funds to aid projects in states through the ACA route.

(4) Assistance for Central and Centrally Sponsored Schemes

The erstwhile Planning Commission used to allocate funds for ACA (assistance for externally aided projects and other specific project) and funds for Centrally Sponsored Schemes (CSS). State-wise allocation of both ACA and CSS funds are prescribed by the centre.

Central Schemes and Centrally Sponsored Schemes(CSS) are already discussed in detail in the previous posts. The central government has been trying to restructure many of the CSS and to limit its number. Most of the states prefer direct funds which offer greater flexibility. CSS offers less flexibility.

Summary: 14th Finance Commission (FFC) substantially enhanced the share of the States in the Central divisible pool from the current 32 % to 42 %, which is the biggest ever increase in vertical tax devolution. Such tax devolution is untied and can be spent as desired by the States.

FC provides post-devolution revenue deficit grants for States where devolution alone could not cover the assessed gap. Normal Central Assistance, Special Plan Assistance, Special Central Assistance and Additional Central Assistance for other purposes are subsumed in the award itself.

CSS is now the biggest component of central assistance to state plans and is now synonymous to Central Assistance (CA).

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Finance Commission while announcing the center-state tax share split deals only with the vertical tax devolution. This is confusing. according to article 280 FC deals with “The distribution of the net proceeds of taxes to be shared between the Center and the states,and the allocation between the states, the respective shares of such proceeds…” then how can we say that it deals with only vertical tax devolution…?

the calculation you mentioned in non plants and grants is based on 13 th finance recommendation. and this formula is used for only tax devolution(horizontal)…your mentioning of tax devloution and grants is wrong as the formula is only used for tax devolution…in case of grants we do not use any formula..it is money in absolute terms..(post-devolution revenue deficit grants for States)

The States of Andhra Pradesh, Assam, J&K, Himachal Pradesh, Kerala, Manipur, Meghalaya, Mizoram, Nagaland, Tripura and West Bengal (a total of 11 States) have been identified for receiving these revenue deficit grants.